Files: ch02, Chapter 2: Investment Alternatives

Multiple Choice Questions

1. The largest single institutional owner o common stoc!s is:
a. mutual un"s.
#. insurance companies.
c. pension un"s
". commercial #an!s
Ans: c
$iicult%: Mo"erate
&e: 'rgani(ing Financial Assets
2. )hich o the ollowing is not one o the characteristics o the primar%
nonmar!eta#le inancial assets owne" #% most in"ivi"uals*
a. high li+ui"it%
#. high return
c. oten issue" #% the ,.-. government
". low ris!
Ans: #
$iicult%: Mo"erate
&e: .onmar!eta#le Financial Assets
/. -avings accounts are 0000000000 #ut are not000000000000.
a. negotia#le1 li+ui".
#. mar!eta#le1 li+ui".
c. li+ui"1 personal
". li+ui"1 mar!eta#le
Ans: "
$iicult%: "iicult
&e: .onmar!eta#le Financial Assets
2. .onmar!eta#le inancial assets that protect against inlation inclu"e:
a. .onnegotia#le certiicates o "eposit 3C$s4
#. Mone% mar!et "eposit accounts 3MM$As4
c. -eries 55 ,- government savings #on"s
". ,- government savings #on"s, I #on"s
Ans: "
$iicult%: Mo"erate
&e: .onmar!eta#le Financial Assets
10 Chapter Two
Investment Alternatives
6. Treasur% #ills are tra"e" in the 000000000000000000000 .
a. mone% mar!et.
#. capital mar!et.
c. government mar!et.
". regulate" mar!et.
Ans: a
$iicult%: 5as%
&e: Mone% Mar!et -ecurities
7. )hich o the ,.-. Treasur% securities is alwa%s sol" at a "iscount*
a. Treasur% #ills
#. Treasur% notes
c. Treasur% #on"s
". Treasur% inlation protecte" securities 3TI8-4
Ans: a
$iicult%: Mo"erate
&e: Mone% Mar!et -ecurities
9. )hich o the ollowing statements regar"ing mone% mar!et instruments is
not true*
a. The% ten" to #e highl% mar!eta#le.
#. The% have maturities rom 1 to / %ears.
c. The% ten" to have a low pro#a#ilit% o "eault.
". Their rates ten" to move together.
Ans: #
$iicult%: Mo"erate
&e: Mone% Mar!et -ecurities
:. )hich o the ollowing woul" not #e consi"ere" a capital mar!et securit%*
a. a 200%ear corporate #on"
#. a common stoc!
c. a 70month Treasur% #ill
". a mutual un" share
Ans: c
$iicult%: Mo"erate
&e: Capital Mar!et -ecurities
;. The coupon rate is another name or the:
a. mar!et interest rate.
#. current %iel".
11 Chapter Two
Investment Alternatives
c. state" interest rate.
". %iel" to maturit%
Ans: c
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
10. =ero0coupon #on"s are similar to Treasur% #ills in that #oth:
a. are issue" e<clusivel% #% the ,.-. Treasur%
#. are mone%0mar!et securities
c. are capital0mar!et securities
". are sol" at less than par
Ans: "
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
11. 5ach point on a #on" +uote represents:
a. >100
#. 1 percent o >100
c. 1 percent o >1000
". >1000
Ans: c
$iicult%: "iicult
&e: Fi<e"0Income -ecurities
12. Treasur% -T&I8- are most similar to which t%pe o corporate securit%*
a. preerre" stoc!
#. premium #on"
c. high0%iel" #on"
". (ero0coupon #on"
Ans: "
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
1/. ?on"s tra"e on an accrual interest #asis. This means an investor:
a. can sell a #on" at an% time without losing the interest that has accrue"
#. can #u% a #on" at an% time an" gain the interest accrue" rom the time o the last
pa%ment
c. can sell a #on" at an% time an" retain the interest portion o the #on"
". #u% a #on" at an% time an" receive an imme"iate interest chec!
Ans: a
12 Chapter Two
Investment Alternatives
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
12. ?on"s calle" in are li!el% to #e:
a. #on"s alrea"% in "eault
#. reissue" as new #on"s with a lower interest rate
c. reissue" as new #on"s with a higher interest rate
". @un! #on"s
Ans: #
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
16. )hat will a #on" #e worth on the "a% it matures*
a. >0
#. >100
c. its ace value 3plus remaining coupon, i applica#le4
". its remaining coupon, i applica#le
Ans: c
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
17. )hich o the ollowing statements is true regar"ing an investment in mortgage0
#ac!e" securities*
a. There is little "eault ris!.
#. The state" maturit% is generall% 10 %ears.
c. The% receive a i<e" pa%ment per month.
". The% are not su#@ect to prepa%ment.
Ans: a
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
19. A municipal #on" issue that was sol" to inance a toll #ri"ge woul" most li!el% #e
a:
a. general o#ligation #on".
#. revenue #on".
c. special assessment #on".
". (ero0coupon #on".
Ans: #
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
1/ Chapter Two
Investment Alternatives
1:. )hat is the ma@or "ierence #etween municipal #on"s an" other t%pes o #on"s*
a. Municipal #on"s are alwa%s insure"1 other #on"s are not
#. ,nli!e other #on"s, municipal #on"s sell at a "iscount
c. Municipal #on" interest is ta<0e<empt1 interest on other #on"s is not
". There is no #ro!erage commission on municipal #on"s unli!e other #on"s
Ans: c
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
1;. An investor who pa%s ta<es at the 2:A marginal ta< rate woul" nee" to earn what
coupon rate on a corporate #on" similar in all respects other than ta<es to a 6A
coupon municipal #on":
a. 1.20A
#. 2.60A
c. 6.00A
". 7.;2A
Ans: "
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
20. Interest on #on"s is t%picall% pai":
a. monthl%
#. +uarterl%
c. semiannuall%
". annuall%
Ans: c
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
21. Treasur% #on"s generall% have maturities o:
a. 6 to 16 %ears
#. 6 to /0 %ears
c. 10 to 20 %ears
". 10 to /0 %ears
Ans: "
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
22. A corporate #on" with a rating o ???0 is consi"ere" to #e which o the
ollowing*
12 Chapter Two
Investment Alternatives
a. non0investment gra"e
#. investment gra"e
c. speculative gra"e
". @un!, or high0%iel"
Ans: #
$iicult%: "iicult
&e: Fi<e"0Income -ecurities
2/. An unsecure" #on" is !nown as a:
a. "e#enture
#. in"enture
c. mortgage #on"
". @un! #on"
Ans: a
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
22. )hich o the ollowing 100%ear, AAA rate" #on"s woul" have the lowest %iel"*
a. corporate #on".
#. insure" municipal #on".
c. ,.-. Treasur% #on".
". mortgage0#ac!e" #on".
Ans: #
$iicult%: "iicult
&e: Fi<e"0Income -ecurities
26. For ,.-. companies, "ivi"en"s are t%picall% pai":
a. monthl%
#. +uarterl%
c. semi0annuall%
". %earl%
Ans: #
$iicult%: 5as%
&e: 5+uit% -ecurities
27. I an investor states that Intel is overvalue" at 76 times, he is reerring to:
a. earnings per share
#. "ivi"en" %iel"
c. #oo! value
". 8B5 ratio
Ans: "
16 Chapter Two
Investment Alternatives
$iicult%: "iicult
&e: 5+uit% -ecurities
29. 0000000000000000 represent shares o oreign companies !ept in #an!s.
a. converti#le #on"s
#. American $epositor% &eceipts 3A$&s4
c. asset0#ac!e" securities
". C5A8-
Ans: #
$iicult%: 5as%
&e: 5+uit% -ecurities
2:. )hich o the ollowing statements regar"ing common stoc!s is true*
a. The par value o common stoc! is usuall% >100
#. The mar!et value o common stoc! is e+ual to its #oo! value
c. $ivi"en"s on common stoc! are at the "iscretion o the compan%
". Common stoc! has a senior claim on compan% assets
Ans: c
$iicult%: Mo"erate
&e: 5+uit% -ecurities

2;. I a preerre" stoc! issue is cumulative, this means:
a. unpai" preerre" stoc! "ivi"en"s are pai" at the en" o the %ear
#. unpai" preerre" stoc! "ivi"en"s are legall% #in"ing on the corporation
c. unpai" preerre" stoc! "ivi"en"s must #e pai" in the uture #eore common stoc!
"ivi"en"s can #e pai"
". unpai" preerre" stoc! "ivi"en"s are never repai"
Ans: c
$iicult%: Mo"erate
&e: 5+uit% -ecurities
/0. )hich o the ollowing statements is true regar"ing asset0#ac!e" securities
3A-?4*
a. The% oer relativel% high %iel"s
#. The% have relativel% long maturities
c. The% generall% have low cre"it ratings
". 5ach traunche has the same ris!
Ans: a
$iicult%: Mo"erate
&e: Asset ?ac!e" -ecurities
17 Chapter Two
Investment Alternatives
/1. )hat is the #iggest "ierence #etween an option an" a utures contract*
a. 'ptions are tra"e" on e<changes whereas utures are not
#. 'ptions give investors a wa% to manage portolio ris! while utures "o not
c. 'ptions can #e use" #% speculators to proit rom price luctuations while utures
cannot
". 'ptions give their hol"ers the right to #u% or sell whereas utures contract are
o#ligations to #u% or sell
Ans: "
$iicutl%: $iicult
&e: $erivative -ecurities
/2. The premium on an option is the:
a. par value o the option.
#. price o the option.
c. #oo! value o the option.
". price at which a securit% ma% #e #ought or sol" using the option.
Ans: #
$iicult%: Mo"erate
&e: $erivative -ecurities
//. I a call option has a >10 stri!e price, an" the un"erl%ing stoc! is tra"ing at >11,
then the option is consi"ere":
a. in the mone%.
#. at the mone%.
c. out o the mone%.
". worthless.
Ans: a
$iicult%: 5as%
&e: $erivative -ecurities
True0False Questions
1. $irect investing involves tra"es ma"e #% "irectl% purchasing shares o a inancial
interme"iar%.
Ans: F
$iicult%: Mo"erate
&e: 'rgani(ing Financial Assets
19 Chapter Two
Investment Alternatives
2. An e<ample o in"irect investing woul" #e #u%ing shares in a mutual un".
Ans: True
$iicult%: 5as%
&e: 'rgani(ing Financial Assets
/. .onmar!eta#le investments woul" inclu"e savings accounts at #an!s an" Treasur%
#ills.
Ans: F
$iicult%: Mo"erate
&e: .onmar!eta#le Financial Assets
2. Mar!eta#le securities all all into the categor% o capital mar!et securities.
Ans: F
$iicult%: Mo"erate
&e: .onmar!eta#le Financial Assets
6. All ,. -. government securities are consi"ere" mar!eta#le securities.
Ans: F
$iicult%: 5as%
&e: Mone% Mar!et -ecurities
7. Mone% mar!et securities generall% carr% a low chance o "eault.
Ans: T
$iicult%: Mo"erate
&e: Mone% Mar!et -ecurities
9. The mone% mar!et securit% most oten use" a #enchmar! or the ris!0ree rate is
mone% mar!et "eposit account rate.
Ans: False
$iicult%: 5as%
&e: Mone% Mar!et -ecurities
:. The rate sprea"s #etween the "ierent mone% mar!et securities o the same term ten"
to #e +uite large.
Ans: F
$iicult%: "iicult
&e: Mone% Mar!et -ecurities
;. Treasur% notes represent the nontra"e" "e#t o the ,.-. government.
Ans: F
1: Chapter Two
Investment Alternatives
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
10. The capital mar!et inclu"es #oth i<e"0income an" e+uit% securities.
Ans: T
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
11. Term #on"s have a single maturit%.
Ans: T
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
12. The return on a (ero0coupon #on" is "erive" rom the "ierence #etween
the purchase price o the #on" an" its par value.
Ans: T
$iicult%: "iicult
&e: Fi<e"0Income -ecurities
1/. The "eeper the "iscount on a (ero0coupon #on", the lower the eective
return.
Ans: F
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
12. I a #on" has a coupon greater than the current mar!et %iel", it shoul" #e
selling at a premium.
Ans: T
$iicult%: "iicult
&e: Fi<e"0Income -ecurities
16. Calla#le #on"s attract investors #ecause the% can #e re"eeme" earl%.
Ans: F
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
17. TI8- a"@ust or inlation #% a"@usting the rate o interest pai" on the #on".
Ans: F
$iicult%: "iicult
&e: Fi<e"0Income -ecurities
1; Chapter Two
Investment Alternatives
19. The ma@or attraction o municipal #on"s is their e<tremel% low ris!.
Ans: F
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
1:. Investors in high ta< #rac!ets woul" #e unli!el% to invest in municipal #on"s.
Ans: F
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
1;. In the case o a corporate #an!ruptc%, #on"hol"ers are pai" #eore an%
"istri#utions are pai" to preerre" or common stoc!hol"ers.
Ans: T
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
20. ?on" ratings are primaril% use" to assess interest rate ris!.
Ans: F
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
21. The ma@or #on" rating service is $un D ?ra"street.
Ans: F
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
22. The earnings retention rate is calculate" as 1 E "ivi"en" %iel".
Ans: T
$iicult%: 5as%
&e: 5+uit% -ecurities
2/. The par value on common stoc! sets the value that stoc!hol"ers will
receive in case o #an!ruptc%.
Ans: F
$iicult%: 5as%
&e: 5+uit% -ecurities
22. C5A8- have maturities "ates up to 10 %ears.
Ans: F
$iicult%: 5as%
20 Chapter Two
Investment Alternatives
&e: 5+uit% -ecurities
26. Most utures contracts are not e<ercise".
Ans: T
$iicult%: Mo"erate
&e: 5+uit% -ecurities
27. Converti#le #on"s give their investors the right to convert the #on" into common
stoc! whenever the% choose.
Ans: T
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
-hort0Answer Questions
1. $istinguish #etween "irect an" in"irect investing.
Answer: $irect investing E #u% #on"s an" stoc!s
In"irect investing E #u% mutual un"s, contri#ute to pension plans, #u% lie insurance
policies.
$iicult%: 5as%
2. Compare the cash lows an investor e<pects rom coupon #on"s, (ero0coupon
#on"s, an" preerre" stoc!.
Answer: Coupon #on"s E annuit% o interest pa%ments plus lump sum o
principal at maturit%
=ero0coupon #on"s E principal at maturit%
8reerre" stoc! E annuit% a" ininitum 3perpetuit%4
$iicult%: Mo"erate
/. Fow is the earnings retention rate relate" to the "ivi"en" pa%out rate*
Answer: 5arnings retention rate G 1 0 "ivi"en" pa%out rate
$iicult%: Mo"erate
&e: 5+uit% -ecurities
2. Fow is the total #oo! value o e+uit% aecte" #% stoc! splits*
Answer: -toc! splits "o not aect total value o e+uit% or the in"ivi"ual accounts,
other than the num#er o shares outstan"ing an" the par value.
$iicult%: Mo"erate
&e: 5+uit% -ecurities
21 Chapter Two
Investment Alternatives
6. In what sense is a stoc! selling or 12 times earnings HcheaperI than a stoc! with
a 8B5 ratio o 20*
Answer: I a stoc! is tra"ing at 12 times earnings, is cheaper than the one tra"ing at 20
times earnings in the sense investors get >1 o earnings or onl% a >12 investment
in #u%ing the stoc!.
$iicult%: Mo"erate
&e: 5+uit% -ecurities
7. )hat are two "irect an" one in"irect metho" or in"ivi"uals to invest in oreign
stoc!s*
Answer: ?u% securities "irectl% through e<changes or as American "epositor% receipts
an" in"irectl% through mutual un"s.
$iicult%: Mo"erate
&e: 'rgani(ing Financial Assets, 5+uit% -ecurities
9. 5<plain how writing option contracts 3#oth puts an" calls4 can generate income
or owners o the un"erl%ing stoc!.
Answer: The writer !eeps the option premium regar"less o whether or not the option is
e<ercise".
$iicult%: Mo"erate
&e: $erivative -ecurities
:. &an! 3lowest to highest4 the ollowing securities in terms o the ris!0e<pecte"
return tra"eo rom the investorsJ viewpoint: common stoc!, corporate #on"s, ,.
-. Treasur% #on"s, options, preerre" stoc!..
Answer: ,. -. Treasur% #on"s, corporate #on"s, preerre" stoc!, common stoc!, options
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities, 5+uit% -ecurities, $erivative -ecurities
;. )hat are some a"vantages o asset0#ac!e" securities to investors*
Answer: Figh %iel"s with managea#le ris!.
$iicult%: Mo"erate
10. )ho #eneits rom a utures contract, a call contract, an" a put contract, i prices
all*
Answer: The seller o the utures contract, the writer o the call contract, an" the #u%er o
the put contract.
$iicult: Mo"erate
&e: $erivative -ecurities
5ssa% Questions
22 Chapter Two
Investment Alternatives
1. $o the stoc! options mar!ets help sta#ili(e or "esta#ili(e the stoc! mar!ets*
5<plain.
Answer: 'ptions shoul" #e a sta#ili(ing orce i options are use" to he"ge stoc!
positions. 'ptions might #e "esta#ili(ing i use" or speculation.
$iicult%: "iicult
&e: 5+uit% -ecurities, $erivative -ecurities
2. Fow "o asset0#ac!e" securities improve the low o un"s rom savers to
#orrowers*
Answer: Asset0#ac!e" securities can #e sol" to a #roa"er mar!et o investors than the
un"erl%ing securities.
$iicult%: Mo"erate
&e: Fi<e"0Income -ecurities
1. )hat state" coupon rate woul" a ta<a#le corporate #on" have to have to #e
compara#le to a municipal #on" with a coupon rate o 9 percent i the investor is
in the 2: percent ta< #rac!et*
Ans: Ta<a#le e+uivalent %iel" is 0.09B3100.2:4 G ;.92A
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
2. A corporate investor in a /2A marginal income ta< #rac!et can #u% #on"s issue"
#% a petroleum e<ploration compan% %iel"ing 10.707A. The investor shoul" #e
willing to #u% ta<0e<empt municipal #on"s o similar +ualit% %iel"ing what
percent or higher*
Ans: 10.707 < 31.000./24 G 9.00 percent
$iicult%: 5as%
&e: Fi<e"0Income -ecurities
/. The par value o ?la(e, Inc. common stoc! is >0.60, the earnings per share is >2,
the mar!et price is >70, the "ivi"en" per share is >1. Calculate the "ivi"en" %iel".
Ans: $ivi"en" %iel" G >1B>70 G 0.0179 G 1.79A
$iicult%: Mo"erate
&e: 5+uit% -ecurities
2. The par value o ?la(e, Inc. common stoc! is >0.60, the earnings per share is >2,
the mar!et price is >70, the "ivi"en" per share is >1. Calculate the pa%out ratio.
Ans: 8a%out rate G >1B>2 G 0.26 G 26A
$iicult%: Mo"erate
&e: 5+uit% -ecurities
2/ Chapter Two
Investment Alternatives
6. The par value o Inerno, Inc. common stoc! is >0.60, the earnings per share is >7,
an" it tra"es at a 8B5 o 16. )hat is Inerno, Inc.Js stoc! price*
Ans: -toc! price per share is 5arnings per share < 8B5 G >7 < 16 G >;0
$iicult%: Mo"erate
&e: 5+uit% -ecurities
22 Chapter Two
Investment Alternatives